The pointy-head caucus can exhale -- the Second Circuit ruled on the pari passu drama, and it did not go as I had expected. Not only did the court rule against Argentina, but it did so on relatively broad grounds, giving a fair amount of meaning to a massively indeterminate bit of Latin, and ignoring the practical challenges of enforcing the ruling. The judges upheld the injunction directing Argentina to pay holdout creditors who refused to participate in its 2005 and 2010 debt exchanges whenever it services the new bonds that came out of the exchange. Ironically, the opinion acknowledged that it was impossible to figure out what proportionate payment would mean under the circumstances, but chucked the question back at the lower court. The judges also remanded the question of how exactly one might enforce this injunction without attaching sovereign property abroad or dragging in third parties (New York banks moving Argentina's money), despite the fact that the holdouts admitted in court that their next step would be to go after the banks on aiding and abetting theories. But these are all questions for another day. Between this ruling and the Ghana boat mess, October 2012 will go down as a heady month for Elliott and its kind.

Here are my main take-aways so far:

The court did not anchor its interpretation of the pari passu clause in Argentina's Lock Law, which bars the government from paying the holdouts, though the law got plenty of play. This was both risky and smart. It was risky because the court's reasoning might be construed to suggest that securities disclosure telling prospective holdouts that they would not be paid was tantamount to payment subordination. It was smart because a decision based solely on the Lock Law could be made moot by its repeal. I bet the "Risk Factors" sections of sovereign prospectuses are getting a close read just now.

The court adopted wholesale Elliott's reading of Argentina's two-part pari passuclause -- "[t]he Securities will constitute . . . direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu without any preference among themselves. The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness ..." (court's emphasis) -- effectively to punish Argentina for payment discrimination, whether or not it had subordinated the securities themselves. This is a big deal for two reasons.

First, violating the pari passu clause just got much easier, though I am not sure how far we can take the implications. Would missing a payment to one creditor while paying another amount to a distinct violation, and give the aggrieved creditor specific performance? This will depend on the precise wording of the clause, but the range of possibilities is considerably wider.

Second, contract drafters have a great new reason to let go the boilerplate schtick. Of course no one will start drafting each word from scratch. But this panel's textualist reading, interpretation technique straight out of Contracts textbooks, and its skepticism of Argentina's evidence on market custom, should jolt the contract production process. Not all bad.

The U.S. government got no love whatsoever. This could be because of the United States' awkward position of avoiding the Lock Law (still the right thing to have done, in my view), its pale oral argument, or because the opinion seemed determined to bracket its enforcement and policy implications. The goal was to bolster contracts and punish very bad debtors. So what if there is no way of enforcing the injunction without grabbing offshore property or New York banks--we are just telling Argentina what to do. So what if Greece has holdouts--its contracts are not under New York law. So what if the reading seems to cover international organizations -- creditors say they are not after them.

The opinion mentions Collective Action Clauses twice as both important, and a meaningful bar to future pari passu litigation. This is completely, totally, unambiguously wrong for all the reasons I have given before, and I cannot believe the judges did it when they did not have to. On the bright side, it gives me and my buddies more to write about.

This may not be as radical as it seems. Everyone would acknowledge that Argentina is an extreme case of vocal intransigence, even by defaulting sovereign standards. In another extreme case last summer, an English judge put an outer boundary on the use of exit consents in distressed debt exchanges. While initial reporting (mine included) suggested that this might seriously damage an established restructuring technique, later analysis suggested more of a modulation. I have said in the past that whatever pari passu means, Argentina is the closest I have seen to breach. Well, now a court says it too, if a bit more strongly than I would. Is it open season on sovereigns via pari passu, consequences be darned? I doubt it.

It is not over by a long shot. Apart from all the decisions that still have to be taken by the lower court on remand (which could end up gutting the injunction), Argentina will surely appeal. It will ask the full circuit to hear the case, and if it loses again, it will try to go to the Supreme Court. Much excitement to come, with lots of law to be made.

If I were Argentina, an agent bank, or much of the sovereign establishment, I would be shocked and dismayed. If I were Elliott, I would be dancing the jig. As it stands, I am looking forward to some really interesting law and policy developments to come.

Comments

But what does Elliott win?

If nobody can do anything to stop Argentina from transferring funds to intermediary banks and intermediary banks cannot be interfered with in making transfers to bondholders pursuant to Argentina's particular requests, how does Elliott end up with any money?

I know the intermediary bank issue is on remand, but it seems the Second Circuit is saying that the injunction cannot stop banks from paying exchange bondholders without paying defaulted bondholders.

The question in my mind is whether intermediary banks would touch anything Argentina with a ten-foot pole now, and if yes, what might it cost. Note also that because the math is totally up in the air, the injunction cannot be enforced until J. Griesa figures it out.

This is really fascinating, in large part because it's very much unexpected. Two questions come to mind:1) If by some act intermediary banks are in fact forced to follow the injunction, forcing Argentina to make a pro-rata payment to holdouts in order to continue servicing their performing debt, doesn't this mean that it constitutes an event of default on the currently performing debt? If memory serves me correctly, the exchange bond prospectus says that Argentina is not allowed to give holdouts a better offer than what it initially offered everybody. Does this matter at all to the courts?2. What would the timing look like for an injunction to be enforced, assuming that the Second District affirms whatever Griesa comes back with? This case has dragged on for a while but I wonder if we might see an unravelling within the next year or so.

Quite the unexpected decision. And, Anna, you're completely right that the court doesn't seem to grasp the relevance of CACs. On a couple of occasions, it says that CACs eliminate the possibility of holdout litigation, which of course is not the case. As you've pointed out before, most modern CACs are drafted in a way that allows holdout creditors to buy blocking positions in relatively small issues. No majority vote, no restructuring. From the opinion, it's obvious that the court doesn't grasp this.

On the other hand, I suspect the court went on its CAC bender in response to the US government's concern that injunctions like this might, in a future case, block a restructuring. And while CACs don't prevent holdouts - at least, not unless the bond provides for an aggregated vote across every bond issue - they probably do prevent holdouts from blocking a restructuring. (Not that holdouts block restructurings now, but, you know...) With CACs in place, won't holdouts be limited to buying reasonably small positions in reasonably small issues, so that the country can still get plenty of debt relief?

I cry not for Argentina, but maybe the intermediate banks do. The law says that they are fair game in asset forfeiture cases. But they are limited-- banks nowadays try to avoid criminals and banks that deal with criminals, and prosecutors are busy people.

Around 2002, the Second Circuit expanded this to admiralty. After years of howling by the banks, the court reversed itself. (The cases: Winter Storm and Jaldhi.) There has been another recent raft of cases along these lines inspired by the New York Court of Appeals in some truly knuckleheaded decisions: Hotel 71 and Koehler. (That's the highest state court.)

The problem, from the intermediate banks' perspective, is fairly simple. Garnishment is a middleman process. The garnishee gives to the court, and is compensated by the extinction of its creditor's asset. This works fine in one jurisdiction. But if you get multinational, there is no guarantee that a foreign court will recognize the extinction of its debt to its creditor (here, the respondent of the US correspondent bank). Indeed, it is often very likely that the foreign court would get rather huffy. It is being asked to choose between harming the respondent (who still owes its customer money) while violating norms of private international law, or complying with the norms and helping the locals. In law Latin, that's a no-brainer.

This is what happens when courts of appeal don't care if their decisions fit into reality (and when judges are briefed by recent law review editors with all the real world experience of Paris Hilton). This is a complete mess, and the CAC issue and the handling of holdouts is only the start. Following on Fernando's comments, if I were Argentina, I'd conclude that the US has already declared me in default in all respects and move my pieces around the board accordingly. Apparently the Second Circuit, for all its supposed cutting-edge decisions, still thinks money in the bank is physical money in a physical bank instead of electrons in a computer that can be moved to Dubai in the wink of an eye. And all future transactions just have to be in entities that can't be dragged into court in Manhattan (and yes, it can be done). The only thing Argentina really needs to avoid is jurisdictions like Ghana with judge-shaped objects that don't know the difference between waiver of sovereign immunity to suit and waiver of sovereign immunity to execution.

Elliott can dance all the jigs it wants, but it's likely to learn what I've been telling clients for over 25 years: Just because you have a judgment doesn't mean you can collect on it.